Tax exemptions for certain business owners are unfair and need to be changed to shore up the state’s finances, Kansas Senate President Susan Wagle says.
Wagle, one of Gov. Sam Brownback’s closest political allies, seems poised for a showdown with the governor over tax policy when lawmakers return to Topeka on Wednesday with the goal of fixing a budget deficit.
She’ll have backup. Several other key Republican lawmakers are calling for changes to the 2012 tax law, which Brownback championed.
The law reduced individual income tax rates and eliminated income tax for more than 330,000 business owners. It has been blamed for helping to create the budget shortfall.
The state is on pace to spend about $800 million more than it is projected to take in during the next fiscal year.
Lawmakers plan to use one-time transfers from the state highway fund and other sources to fill about half of that hole. But they still need to come up with about $422 million in tax increases or budget cuts to break even, according to the state’s nonpartisan Legislative Research Department.
State coffers would have about $1 billion more had the 2012 income tax cuts not become law, according to Legislative Research.
It’s almost a certainty that taxes will be increased to plug the budget hole. But the question remains: which taxes and who pays them?
Brownback wants to use consumption taxes — increases on tobacco and alcohol — to help plug the hole.
The governor has proposed slowing future income tax cuts but has resisted moving rates back to earlier levels or changing the business exemption. He has repeatedly touted these policies as key to spurring economic growth.
Asked about lawmakers’ desire to revisit the 2012 tax changes, Eileen Hawley, the governor’s spokeswoman, responded in an e-mail: “The Governor will work with legislators on building a structurally balanced budget while continuing our transition from a tax on productivity to consumption-based taxes.”
Wagle, R-Wichita, expects consumption taxes to be part of the final budget fix, but she also said lawmakers need to revisit the unintended consequences of the 2012 tax law.
She said the exemption for business income, which she voted for, was intended to create jobs by allowing small businesses to keep their profits and reinvest them in the company. But she added that the law has allowed business owners to keep their salaries untaxed and has allowed one-man shops to go completely untaxed.
“The intention wasn’t to give a break to the owners. The intention of that original policy was to not tax the business profits so they could be reinvested,” she said.
The law has created an inequitable tax system, she said.
“What’s evolved since we passed that plan is, you know, a CPA that works for a firm pays income tax, but a CPA who’s hung out a shingle and works independently pays no income tax,” Wagle said. “Or a painter. Or an engineer. Or a dentist. Or a lobbyist. It’s all professions and that’s just unfair. It’s unfair tax treatment.”
Wagle said she and Brownback have discussed the issue but have yet to reach agreement. She added that lawmakers would consider several ideas about how to tweak the exemption.
Sen. Jim Denning, R-Overland Park, floated an idea earlier in the session to have business owners pay no tax on a portion of their income but pay taxes on the rest.
Other options include allowing the exemption to apply only to money that stays within the business rather than money that goes into a person’s own bank account or narrowing the type of entities that qualify with the goal of job growth.
The exemption now covers a wide range of businesses, from a person who sells knick knacks out of his or her garage to larger companies that file as LLC’s or S corporations.
About 72,000 business entities pay unemployment tax, according to the Kansas Department of Labor. Wagle said this suggests that a large number of the 330,000 beneficiaries of the tax exemption are one-man shops that do not intend to hire new employees.
House Taxation chair Marvin Kleeb, R-Overland Park, wants to restore what he says was lawmakers’ intent when they passed the tax bill.
“We always thought there was going to be some taxation on small businesses and it turns out there was a lot more that was exempted than we thought once you got into it,” Kleeb said. “We’re going to take a look at passive income. We’re going to take a look at royalties. I don’t think any of us ever intended for those to be escaped from taxation.”
Kleeb said the focus for lawmakers would be to “help those businesses that have employees and have the ability to continue to create and grow jobs.”
The National Federation of Independent Businesses, which represents 4,200 Kansas businesses, has mounted a lobbying campaign against any changes to the exemption.
“The idea that we’re going to go back on that plan, roll back that plan, before it’s even had time to grow roots is to me counterproductive,” said Dan Murray, NFIB’s state director.
“We would like to see additional efforts to find efficiencies,” Murray said. “I think there are always efficiencies that can be found. I think the issue that we’re facing now is the political reality to finding 21 votes in the Senate and 63 votes in the House to pass something. In my professional judgment it doesn’t appear that there’s political will to cut their way out of this problem.”
It’s unlikely that additional budget cuts will make up a large chunk of the final fix. Republican lawmakers previously passed a bill to fund schools through the 2016-17 school year and they say that funding is off limits. They also want to safeguard funding for Medicaid and higher education.
“I’ve cut about all I can cut,” said Denning, vice chair of the Ways and Means Committee, which oversees the budget.
Denning said Republican lawmakers will have to take tough votes on taxes to fill the budget hole and keep their promise to schools. Republicans control the Legislature and they own the tax policy, he said.
“It happened on our watch. And it’s up to us to govern and fix it,” Denning said. “And you know, it’s going to be painful as all get-out to talk about tax increases and actually do it, but I’m going to do it. I’m not going to wring my hands and gnash my teeth. I’m ready to put this thing to bed and stabilize the budget.”
Denning said he doesn’t want to raise income tax rates but is prepared to close loopholes.
Rep. Tom Sawyer, D-Wichita, the ranking Democrat on the House Tax Committee, called Denning’s scrutinizing of the LLC exemption a good start.
“They’ve got to have some skin in the game,” he said of business owners who pay no income tax. “It’s unfair to raise taxes on working families when they’re (business owners) paying no taxes.”
How to increase tax revenue
Rep. Ron Ryckman Jr., R-Olathe, who chairs the House Appropriations Committee, said most Republicans realize the need to increase tax revenue, and the debate will be whether to do so through consumption taxes or income taxes. “It could be a blend.”
Brownback has proposed slowing scheduled cuts for personal income tax and increasing taxes on alcohol and tobacco, among other steps. All together, his plan is projected to bring in $211 million in additional revenue.
Even if that passes in its entirety, lawmakers will need to come up with more than $200 million to fill the shortfall. And portions of the governor’s tax plan – particularly the tax hikes on alcohol and tobacco – have proven unpopular with lawmakers. Administration officials say they do not plan to offer additional tax proposals.
Among Republican senators there’s a consensus that lawmakers need to produce a long-term fix to the state’s revenue system so that this problem doesn’t persist year after year, Wagle said.
“I think that the end package, because the hole is so deep, will be a mix of taxes with the goal of creating tax fairness and the goal of protecting growth in the state of Kansas, economic growth,” she said.
“I think everything’s still on the table. I just think there’s more awareness in the Legislature that now is the time to fix the income tax bill that passed in 2012.”